Are Diamonds the New Gold?

In a week in which gold suffered its biggest price decline in 30 years, one former futures trader is here to herald the next long-term commodity star—diamonds. Yet others insist that reports of gold's death are greatly exaggerated.

Kristopher Schellhas has invested heavily in what he regards as the rotation into the next big investment wave. The former Chicago Board of Trade futures trader, together with partner Chris Duffield, a former hedge fund trader, are not simply going long on diamonds. They have created an exchange to facilitate others' investments in the light-dispersing gemstone.

Through their newly launched Investment Diamond Exchange, investors can now buy investment-grade diamonds at rock-bottom prices with complete transparency—as well as take physical possession, track prices in real time and liquidate their portfolios.

The two Los Angeles-based partners want to capitalize on trends that began to emerge when De Beers, through lawsuits and privatization in the early 2000s, lost its more than century-long monopoly over the diamond market.

Kristopher Schellhas "They no longer have the ability to manipulate diamond prices, and their stockpile was officially depleted in 2004," Schellhas (right) tells AdvisorOne. "The market was democratized," he adds, noting that the participation of companies like Alrosa, Rio Tinto, Harry Winston and Petra Diamonds in diamond production have allowed market forces to prevail in the formerly De Beers-dominated industry.

Adding to the new liberalization of the market are what Schellhas regards as exceptional supply-demand characteristics.

"The fundamentals for diamond price appreciation are amazing now because all the existing diamond mines that are substantial are at their peak capacity," he says. "The supply of diamonds are going to remain static for the decade and continuing on till 2030, and no new diamond mines of substantial size have been discovered."

And even if new discoveries are made, Schellhas says it takes 8 to 13 years to get a mine up and running. And while the supply appears attractively limited, Schellhas points to a surge in expected demand coming from China, India, the Middle East and Brazil.

"These emerging economies are fueling unprecedented demand for diamonds and jewelry," he says, noting forecasts of 276 million new middle-class households in China and India by 2020.

"That's more than three times the middle-class households in the U.S. right now," Schellhas says. "These countries have an insatiable appetite for luxury goods. It's woven into their culture. They love jewelry, and of course developed countries are going to buy jewelry as they always do."

But Leigh Greenberg (left), a precious metals dealer with Universal Bullion, also in Los Angeles, counters that demand factors still favor other commodities.

"The demand for jewelry in gold and silver is much higher than for diamonds," he told AdvisorOne. "Diamonds are for weddings—they're one-time purchases. Gold and silver demand is throughout the year."

Apart from diamonds' constricted supply and demand growth in line with emerging economies' GDP growth, which is north of 5% according to a Bain & Co. study Schellhas cites, it may be diamonds' novelty as an investment that makes them shine brighter than gold.

While gold owners may be miffed that their precious metal now trades at a 2-year low, or about $1,400 an ounce, the commodity was priced at just $450 an ounce before the GLD ETF was launched in 2004. Schellhas believes the ETF, by making it easy for ordinary investors to trade, fueled speculative interest in the commodity.

He cites research indicating that 40% of the gold market is speculative capital, compared to a mere 1% speculative investment share for diamonds.

But Greenberg doubts diamonds can rise to gold's age-old status as a store of value.

"If we look at history, gold has always been considered money; diamonds have never been considered money," he says. "People have always used gold for money, barter, trade. Diamonds just don't qualify for that category."

Yet plans afoot to release the first diamond ETF by the end of this year fuel Schellhas' confidence in a coming surge of speculative investment in diamonds.

Schellhas concedes that the uniqueness of each individual diamond has been a barrier to commoditizing them and turning them into a publicly traded asset class.

But a company called GemShares, which will be issuing the aforementioned ETF, has succeeded in patenting a class of "investment-grade diamonds"—specifically, 0.5- to 5-carat, round, brilliant, clear or colorless GIA-certified diamonds—for public trading.

Those are the only diamonds that Schellhas sells through his Investment Diamond Exchange.

Schellhas calls the patent and the investment commoditization process it will launch "a precursor to creating a futures market for diamonds.

"It overcomes all the idiosyncratic features of a diamond; it overcomes the fact that… there's roughly 16,000 variations of this diamond," he says.

While financial advisors are more accustomed to buying financial products such as publicly traded companies involved in mining and production—"more power to you," Schellhas says—the diamond merchant is a big believer in physical possession.

"The process is to buy diamonds and hold onto them because they're unbelievable for appreciation of wealth," he says. "You're taking physical delivery of the diamond. They'll come to your house in an armored truck with beautiful leather cases that fit into your safe. There's no better way to preserve your wealth than to take physical delivery of the diamond itself."

And you avoid the management risk inherent in owning investment companies, Schellhas adds.

The diamond merchant claims to have the lowest available prices, made possible by the arrangements made with cutting and polishing factories in Israel, Belgium and India.

"They compete to get their diamonds on our website," Schellhas says. "Consumers can now have access to diamond pries once available only to insiders. We utterly blow them [competitors] out of the water."

On Friday, the lowest priced 1-carat investment-grade diamond on his website sold for $6,161.11.

"We're creating a spot price for every single diamond. We've driven prices down. We're like a portal connecting investors with prices that are true wholesale prices," Schellhas says.

The site also clearly states a buyback price that is precisely 5% lower than the sales price.

The exchange currently offers $23 million worth of inventory, which Schellhas expects to grow to hundreds of millions in time, but they have no merchandise in their headquarters, which merely administers the exchange and armored truck deliveries.

Schellhas says he is working with several advisors across the country—he named Kubler Financial as one partner—who are not restricted by their arrangements with custodians like Schwab.

Diamonds are "extremely attractive to independent advisory firms," he says. "They're allocating their clients into physical diamonds all the time," citing an advisor in Charlotte, N.C., who just made one client extremely pleased with her sparkling new acquisition. The exchange has a referral agreement for advisors and offers prompt payment, Schellhas says.

"We configure diamond portfolios for the individual needs of each client," he says. "The idea is to help people preserve and grow their wealth."

Going forward, Schellhas says diamonds' time has arrived.

"The smart money is going into this product," he says, citing Zurich-based Diamond Asset Advisors; commodities booster Jim Rogers, and diamond producer Harry Winston having established a $250 million fund for diamond investors.

"They're a hedge against inflation, their volatility is way less than gold, it would be a play on global growth and they perform well in times of intense economic volatility," Schellhas sums up the matter. "It's a very stable asset, returning 15% per year on average since 1959."

On the risk side of the equation, "it would take a serious reduction in growth prospects in these emerging economies to take away that demand," he says, citing something on the order of a revolution in China. "In World War II, these things were used to hide and preserve [people's] wealth."

And he insists that diamonds trump gold.

"Gold was a very stable asset before it was commoditized. You have wild swings now."

As for Universal Bullion's Greenberg, gold's wild swings merely reflect "the insanity of the global economy," a fact that has positive investment implications.

"If gold can move down $140 [an ounce] in one day, it can move up $140 in one day," he says. "It works both ways."

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Read 7 Reasons Gold Is Falling: Currency Manager Merk on AdvisorOne.